Thursday, March 31, 2016

Jed Kolko has some great charts on the Great American Migration (HT: MY). He recognizes the supply problem, but as most people have a tendency to do, he views these patterns implicitly through a lens of demand and consumer preferences. I think we would be better to see this entirely as a supply problem. When a bowl is full, pouring more water in just causes water to run over the top. Those who can afford to outbid incumbents for housing are the water pouring in, and those who can't afford it are the water running over. The high income households moving in are doing it by choice. There is no reason to believe that the households moving out are expressing choice in any way. They are being forced out, and the force is equal to the amount of pain they are willing to suffer before they are willing to pick up and move away from their homes.

These patterns are extreme. Just since 2000, among the bottom half of households, by income, there has been more than a 10% shift away from highly dense urban neighborhoods. These are essentially passively imposed forced relocations. This is the interpretation that deserves the benefit of the doubt. To explain it any other way would be like noting how the Super Bowl (where tickets now cost thousands of dollars) is overwhelmingly attended by rich people, and concluding that there has been a shift in preferences. For some reason, lower income fans just seem to lose interest in football after the regular season ends. Maybe we need to do an anthropological study about why poor fans don't care about championships as much as they care about pre-season exhibitions.

There is a lot of discussion these days about increasing market power of corporations. Larry Summers has an article out on this. I think I will save a more detailed response for another post. He concludes that increasing market power is important because all the other explanations for apparent patterns of income stagnation and inequality are mysteriously incompatible with the evidence. But, he doesn't consider this housing issue. It's housing that has the increased market power. And, this power, ironically, comes mostly from "Affordable Housing" policies in the big blue cities.

The frustrating thing about discussing the economy in terms of market power, is that it sets the discussion up in a satisfying "us vs. them" framing, which is really wrong about everything. It sets us up to look for confiscatory and obstructionist policies that we expect to level the playing field. It leads us to spread all of the policies that have created the problem to an even broader set of agents.

We are the 100%. The solution to all of these problems is building. That means developers making profits on new buildings. It means letting cities grow. Like no other issue I have studied, this housing problem highlights the damage of "us vs. them" thinking, and the shared benefits of an open society and a free economy.

I try to avoid tribal politics, but it is really distasteful to me to see the class warfare and anti-market rhetoric that imbues so much of the anti-building activism. Then, when those policies make refugees out of a sizeable portion of the working class households of those cities, the response is more class warfare. The corporations have too much power! Taxes on the rich are too low! We must be subsidizing those gauche suburbs too much! Raise the minimum wage so corporations that have too much market power have to pay poor workers enough to pay their exorbitant rents!

"The business model of Wall Street is fraud." And, what was "Wall Street's" big sin? Building houses in Riverside, and Phoenix, and Atlanta for those refugees. And we put a stop to it. We are nearly unanimous in our support for the housing bust. Nothing unites America these days like our agreement on this.

The policy impositions of urban activists have turned their cities into a post-modern dustbowl and the jalopies are lined up on I-10, now moving back east. How extreme does this have to get before we can expect a little introspection? Unfortunately, I'm afraid that love politics means never having to say you're sorry.

Wednesday, March 30, 2016

A while back, when I first started thinking through the implications of the localized supply constraints that now are at the center of my story, I posted this graph of the Shiller Real Home Price Index. Dr. Shiller discounts that index with CPI inflation. The idea, I believe, is that over the long term, rent inflation should basically follow general inflation. In theory, this makes sense. And, empirically, it was pretty close to the truth except for some unusual rent inflation in the 1970s. But, since Shiller has developed these tools, we have now had a 20 year period of time with persistently high rent inflation.

Now, if we are trying to decide if home prices are reasonable, it seems to me that, whatever our theory of expected rent inflation, if we have a rent inflation measure, that is the discount rate we should use on a Real Home Price Index.

So, on my first go around with this, I posted this first version of the graph, with my correction.

As you can see, this tames that scary looking monster of a graph quite a bit. We aren't so much overpaying for homes as we are paying higher rents for them. The difference between my graph and his graph is basically a measure of the transfer of wealth we have made to real estate owners in Closed Access cities. About 1/3 of the value of our residential real estate was just a winning lottery ticket for people who happened to own property in places where policy makers became more dysfunctional during their tenure.

But, even my version had a sizable hump in 2005.

Now that I tend to think of these things more locally, it occurred to me that this measure really should be local. A few cities have Case-Shiller home price indexes and CPI Owner Equivalent Rent measures that go back at least far enough to capture the housing boom period.

Here, I have added three cities to the graph: San Francisco, Dallas, and Atlanta.

For 3/4 of the country, irrational or unsustainable prices should not, and never should have been, part what buyers are concerned about if they are deciding to buy a home. It is simply not relevant. Dallas and Atlanta and a hundred other cities have never even remotely moved out of the long term range of home prices. There is nothing to see here.

And, San Francisco isn't hitting the top of the chart because of irrational buyers. It's hitting the top of the chart because there is no end in sight to its dysfunctional housing market. Rents will keep rising until it is fixed. The reason a buyer has to pay so much for a home in San Francisco today is because they have to assume that rents 10 or 15 years from now will be double what they are today. The market failure would be a market where Price/Rent in San Francisco was not any higher than in Dallas.

Buyers in San Francisco aren't banking on the irrationality of the housing market. They are banking on the irrationality of San Francisco housing policy. They really have no choice. The San Francisco Board of Supervisors forces real estate owners there to be wild speculators on the autocratic tendencies of the San Francisco electorate. The Supervisors really have no choice either. You get elected in San Francisco for referring to those beautiful, easy Dallas and Atlanta price trends as "trickle down economics". In San Francisco, you get elected by showing concern for high rents, not for solving them. 75% of the country knows how to avoid rising rents. It must not be that difficult. It's just not how to get elected in San Francisco.

Meanwhile, Robert Shiller, the great economist who has made these wonderful tools available to us, has spent the last 15 years warning people in Dallas and Atlanta about bubbles. And people post pictures of his scary blue line to explain how out of control markets are.

PS: By the way, do you notice that really long period of stability in home prices before the 1970s? Do you think we got that through macroprudential management? Through tight controls on home building?
No. We got it by building and lending. There was consistent growth in mortgages as the New Deal housing policies were implemented. California was growing by 3-5% per year, and real private fixed investment was growing by 5-7% per year. You want stability? Let's try that again. (Ironically, lenient lending and building policies would lead to declining mortgage levels because real estate values would fall. Open access is the sustainable policy regime.)

Tuesday, March 22, 2016

As I think through the implications of my alternative history of the Great Recession, I keep wondering how much of our collective notions about the causes of economic dislocation are a product of attribution error, hindsight bias, and an ancient discomfort we have with risk, in general (finance being the name we have for mechanisms we have developed for sharing and managing risk).

Inevitably, in a culture and an economy that exists above subsistence, saving is required. As abundance has grown over time, forms and outlets for saving and investment have become more complex. For any life more complex than hunting fruits and berries and killing small game, where nature's risks are always at the doorstep, speculation is mandatory. This is true for even the first steps into agriculture.

In our world, we are all involved in wild speculation. We have all optimized for a functional society with a complex array of utilities, public institutions, and market provision of highly technical goods. Frankly, it sort of stresses me out to think about it because we just aren't built to trust the robustness of emergent order, but we all must do just that, to an extreme. Mostly we cope by not thinking about it.

One of the ways we handle this unavoidable speculation is by engaging in a variety of risk-trading relationships, which, for the most part, settle into a set of social conventions that reflect common preferences, so we don't even think about it consciously most of the time. Local certainty appears to be very valuable. Much of finance involves trading local risk. Equity holders take on short term volatility and both creditors and laborers tend to accept a discount to their incomes in exchange for that certainty. This is why stocks generally have higher long term returns than bonds. It is difficult to be tethered to the random walk, both emotionally and as an input in our personal financial plans.

But, there is a necessary trade-off with these risk-trades. The gains in local certainty to laborers and creditors generally must come at the expense of more risks at the extreme. Equity is exposed to constant, small-scale local risk, and in extreme conditions may encounter existential risk. Labor and creditors experience this as a sort of regime shift. They either exist in a context of relative income certainty or in a context of default or unemployment.

Real estate holds an interesting position here. Mortgages with stable payments serve this function for both the borrower and the lender. Homes are real assets - their values change with inflation and with local conditions. Nominally fixed mortgages make a very poor asset-liability match. But, what mortgages provide for both the borrower and the lender is cash flow certainty. We use the general tendency for inflation, and amortization, to essentially push nominal uncertainty off the balance sheet of both the bank and the homeowner.

Note that both labor and creditors basically have made the same risk trade and face the same problems of dislocation when there are nominal spending shocks. But, isn't it interesting how different our reactions to these two classes of participants are?

Political observers and academics both tend to ascribe the causes of dislocations from nominal shocks to financial leverage. But, this is a truism. We are all speculators. We all optimize to some extent to our general expectations. One aspect of this optimization will always involve trading short term risk. If a nominal shock happens that is large enough to cause dislocation, it will, by definition, involve dislocation among these financial relationships that involve the purchase of short term certainty. To ascribe causality to debtors is equivalent to blaming the grass for a drought.

But, you may respond, some people get complacent and take too much risk. And those people are the ones that end up being the first dominoes to fall in a crisis. The causality is right there in front of our eyes to see. Is there any doubt that the housing crisis was heightened by the concentration of recent homebuyers with high leverage? Is there any doubt that the crisis would have been less severe with less leverage? No. There is no doubt. As far as it goes, this response is absolutely reasonable.

But, couldn't we also say that the drought would not have been so bad if the grass had deeper roots? Couldn't we also point to the clever means of water retention that desert plants use and wonder why the grass wasn't doing the same?

My point here is that even if the response is perfectly true, it is also not falsifiable. Any nominal shock that is strong enough to lead to widespread dislocations will appear to have been caused by leverage. Here is a post from the London School of Economics that explores the role of real estate speculation in the lead up to the Great Depression (HT: Benjamin Cole).

Here is a graph from the post. The author, Natacha Postel-Vinay, makes some interesting observations about the real estate market of the time. In some ways there were parallels to the recent crisis. In the 1920s, piggyback loans began to gain popularity. This graph suggests a strange outcome, that in cities with lower 1st lien leverage, foreclosures were higher. She notes that this is because the lower leverage was associated with the use of piggyback loans, which were more vulnerable to economic stresses.

But, note, loan to values on first mortgages at the time were generally 50% or less. The cities with the highest foreclosure rates had LTVs under 40%. And, homeownership rates at the time were under 50%. Actually, even in the recent crisis, average leverage among homeowners was less than 50% at the peak of the boom in early 2006, though there were certainly cities with concentrations of higher leverage. So, if neighborhoods with LTVs above 80% or 90% were the cause of the recent crisis, would we have been better with LTVs under 80%, 70%, 60%? Certainly we would have been less vulnerable to dislocation. But, when dislocation came, would the story have changed? If average LTVs in 2006 had been 30% or 40% instead of 45% or if there was a ban on mortgages with LTVs above 90% or 95%, then when dislocation arrived, would we have said, "Well, we can't blame leverage this time."? Of course not.

And, note what we never claim. We never apply this prescription to labor. Even though the consensus among economists is strong that the difficulty for nominal wages to adjust downward is an important factor in episodes of unemployment, there is never an upswelling of academic papers and political candidates after a crisis that complain about our dangerous tendency to have labor contracts with stable wage levels. We never complain that our unemployment comes from a rigged system where so many laborers recklessly pushed up the operational leverage of firms. Nobody holds press conferences to complain that fixed-salary workers did this to us and bemoan that none have been prosecuted.

Yet, is there any doubt that if we instituted a law that required all labor contracts pay into a rainy day fund that firms could reclaim during nominal shocks that unemployment would be much less of a problem? How reckless of us not to do that! Maybe nominal crises are caused because laborers become complacent when there are long periods of stability. Maybe appropriate public policy should aim to allow frequent employment shocks so laborers don't get complacent.

Funny how that sounds wrong, even though it is basically the same proscription that is seriously offered in the financial realm. Operating leverage and financial leverage are both leverage.

Is there a façade of empiricism here? Do our shared notions about the causes of economic shocks exist in a plane above and disconnected from empiricism? Are we simply projecting our human biases in a subconsciously predetermined narrative?

If leverage is dangerous, the way to reduce it over the long term isn't through cyclical second-guessing. Corporate leverage has actually been very low going into the last two contractions. The reason leverage in general, by some measures, was too high was because low interest rates and supply constraints in housing had increased the value of homes. But, low long term interest rates are hardly a sign of speculative fervor.

If leverage is dangerous, we can easily reduce the advantages that debt gains through tax and public policy. To reduce leverage in housing, we have to start building homes in high value locations. These are structural issues. To solve this cyclically is a public policy minefield, and simply diverts attention from policies that could provide nominal stability. As much gnashing of teeth as their has been about bailouts and excess in the recent crisis, this was a perfect example of a crisis where we introduced extreme nominal instability because we were so concerned about debt. And, since the cause of the crisis was predetermined, when we introduced instability, we still all agreed to blame that debt.

There were observers complaining about housing bubbles as early as 2001 or 2002. But, even when the crisis hit, aggregate home prices never fell below the prices of 2003. Suppose we had introduced enough nominal instability in 2003 to cause home prices then to fall back to 2001 prices. Would the story have changed? Millions of mortgages originated in 2003 and 2004 had low default rates. But, in this scenario, many would have defaulted. Is there any question about where the blame for the instability would have been laid? There is no question. We would have blamed debt and speculation. Yet, we know that there was nothing wrong with those mortgages. They have performed quite well, even though those 2004 cohorts have dealt with volatility unheard of since the Great Depression.

Monday, March 21, 2016

Outsourcing manufacturing to developing economies no more leads to a trade deficit for the US than outsourcing the design of cell phones and PC software leads to a trade deficit for Australia or China. The balance of trade is a reflection of capital flows.

The economic rents captured by real estate owners, firms, and high income workers in Closed Access cities are paying for all those imports. There is no balance of exports we have to create to make up for those imports.

If we solved our urban housing problem, the trade deficit would largely go away. This, in and of itself, would be a bad thing for the US as a whole. It would mean that foreigners have stopped sending us lots of goods and services in exchange for our over-valued services.

But, it would also mean that we would all have more innovative goods and services at lower prices and the cost of living for all Americans would decline significantly, especially those in Closed Access cities. The trade deficit is related to variance in incomes and a "rigged" economy, if you will. But, not in the way it is usually described. It has little to do with "billionaires" or "Wall Street". The rigging is being done by planning commissions in LA, San Francisco & Silicon Valley, New York City, and Boston.

It's a shame that if we fixed this problem, the simultaneous improvement in broad real American incomes and the decline in the trade deficit would be taken as evidence that trade is harmful.

PS. Drops in manufacturing employment are clearly associated with recessions. Yet, there is no bounce back during recoveries. If this is, indeed, attributed to global trade patterns, shouldn't our first obvious response be to change our status as the country with the world's highest corporate income tax?

Oddly, a common response to this is that effective corporate tax rates are actually not that high, because corporations arrange for so many favorable tax breaks. The largest supposed tax break, by far, is to move operations and revenues out of the country to literally any other place in the world. But, for the sake of argument, let's say there are so many domestic tax breaks that corporations really do pay competitive tax rates in the US. So, this argument basically says that US corporate tax policy is fine because as long as corporations curry favor from politicians, they can get a competitive tax treatment in the US. This argument basically demands that corporations rig the tax system. Because, if they don't, locating production in the US saddles them with a 10%+ disadvantage compared to the rest of the world.

In the realm of people who equate trade deficits with falling US manufacturing employment, I see two camps. (1) those who wish to impose punitive policies on foreign producers and (2) those who wish to impose punitive policies on US corporations.

There is an argument that we need to strike a balance between stability and growth. But, as a first step, we need to recognize where arguments against international trade are simply a subset of arguments against progress in general. Where that is the case, proposed solutions to the dislocations caused by international trade need to be convincing in the generalized case as solutions to the dislocations caused by general progress.

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PPS. If dislocations from trade are a concern, reducing the cost of dislocations seems like the primary issue. Some of the concern over trade with, say, China seems to me like it might be measuring the decline in labor mobility that has coincided with the rise of China. This recent paper (pdf) seems to have some interesting findings on that issue (HT: AT). They did not find a correlation with land use regulations and declining labor mobility. But, I can't help but notice the pattern of inter-state migration around the long term trend and the pattern of housing starts and shipments over the same period. The movement of labor migration above trend at the height of the housing boom and the sharp drop below trend after the bust seem to support the idea that the housing boom was facilitating an escape from high cost cities. The peculiar character of the housing supply crisis may muddy the waters a bit on this sort of topic, because the migration was away from high costs and to low costs. It wasn't necessarily away from low employment and to high employment. The constraints of anti-development forces have reversed the normal trends of human migration, so the footprints of this movement in the data will frequently be counterintuitive. Low income households are being driven away from cities that generate lucrative labor opportunities.

Thursday, March 17, 2016

Well, shelter inflation continues to push up, and to inflate the Core CPI measure. But, I must say, the non-shelter core is certainly rising healthily.

Core minus shelter inflation is still under 2%, year over year, and acceleration will probably level off over the next few months, since the next few months due to fall out of the year-over-year measure were generally high. That should give the Fed some cover. Let's hope they use it.

Wednesday, March 16, 2016

The Brookings Institute takes a look at recent data from Pew that suggests the middle class is shrinking, and checks it out on a city by city basis. (HT: TC)

Here is a graphic comparing the size of the middle class within each MSA. What the cities at the top of the list have in common is affordable rent. And the Closed Access cities - urban California, Boston, and New York City - fill up the bottom. Notice how most cities have a middle class between about 47% and 54% of the population, but for those bottom dozen or so metropolitan areas, there is a real drop off.

Below I have also pasted a graph comparing Zillow's measure of rent affordability for the largest 100 metropolitan areas. Notice that this is the mirror image of the measure of the middle class. There is the same sharp deviation from the norm at the bottom of the list. The worst cities are the same coastal metropolises. The same cities appear at the top of the list, too.

And, rent is expensive in the Closed Access cities even though the missing middle income households have largely been replaced with high income households.

The coastal cities are hollowing out the middle class, mostly by refusing to build homes.

Monday, March 14, 2016

The funny thing about trying to read some small portion of the countless books that have been written about the housing bubble is that they are full of facts that are useful for my contrarian point of view. By about 2001, everyone had agreed that the eventual bust of the so-called housing bubble would be caused by overleveraged speculation. So, by 2007, when we had finally engineered the bust that would prove all of our intuitions right, and show those lousy speculators how foolish it is to expect 21st century institutions to support stability, we didn't need to convince one another about the premise.

So, frequently, observers will make arguments that are really arguments against the premise, but they are only presented as arguments against one of the stories that are based on the premise, because the premise was canonical before it was falsifiable.

The fact that commercial building mimicked the behavior of residential housing is used to argue that the GSEs couldn't have caused the bubble. But, advocates of that story want to blame private investors for the bubble, so they don't apply the argument against lenient retail mortgage or subprime securitization. In fact, they should be pushed even farther, because the commercial market strongly suggests there was no bubble at all. Investors in shopping malls, multi-unit housing developments, and offices are about the least speculative people you'll ever meet. Even now, when capitalization rates are strong even while bonds are tickling the zero lower bound, the real estate financial analysts I see generally only talk about the high income potential of real estate investments. I don't think there were many REITs in the market to flip apartment complexes.

Arnold Kling recently repeated one of these types of arguments when he explained that mortgage relief programs wouldn't have accomplished what their backers were hoping for because many of the late homebuyers who defaulted were speculators, not owner-occupiers.

He adds:

(Y)ou face a trade-off. Give the borrowers too generous a bailout, and you generously reward the profligate.

Loans to speculators were made by Freddie and Fannie. Loans to speculators were eligible to be laundered into AAA securities that were favored by government capital requirements. The sad fact is that the real estate lobby was so good at playing the violins for "home ownership" that they were able to put a smokescreen over a wave of speculative borrowing....

Anyone who wants to stop mortgage foreclosures needs to have his head examined. How many of the bad loans are investor loans, where the borrower never occupied the house? 20 percent of them? 50 percent? 70 percent? We know that in the last years of the bubble more than 15 percent of mortgages were for non-owner-occupied (the true figure might actually be higher than reported, because it is common to fraudulently claim that you will be using the home as a residence when you will not). Investor loans default at a much higher rate than regular loans, somewhere between 3 and 10 times as much. If it's 4 times as much, then already we can be surmise that a majority of bad loans are investor loans. The best thing to do with those is to foreclose ASAP.

So, the story that the peak of the bubble was facilitated by predatory banks pushing subprime loans on low income owner-occupiers is wrong. The peak of the bubble was facilitated by investor households with multiple properties. They were, according to Kling, engaging in massive fraud, also.

But, this is a much different story than the predatory lender/over-leveraged owner-occupier story. Kling's story points back to the GSE's and fraudulent investors. Isn't it weird how there are two mutually exclusive versions of the period, but they both include rampant fraud? Profligacy was the premise. We know there were villains. Somebody must have been committing fraud, because prices were so high.

The Mian & Sufi story is that high wealth households lend and low wealth households borrow, and so low wealth households were wiped out when equity values in homes crashed, and the wealthy households that owned their mortgages came out on top. So, this is just another example of the rich getting richer at the expense of the poor.

But, that kind of sounds the opposite of Kling's story, too. Doesn't it? Everybody has a villain. Everybody has cynicism. Everybody sees profligacy. Everybody sees inevitable bust. And it confirms everyone's sense of injustice or poor policies, even if some of those confirmations contradict others. So, we argue about those contradictions.

The one thing everyone agrees on is that we absolutely could not have supported a policy of price or monetary stabilization. Stabilization rewards profligacy. You'd need to have your head examined to stop foreclosures, says Kling.

Here are some statistics from the Survey of Consumer Finances. About 75% of mortgages for primary residences were held by the top 40% of households, by income. About 85% of mortgages for other residential properties were held by the top 40% of households - more than half by the top 10% of households by income. Aren't these the households that would be least affected by changing credit conditions? Isn't it strange that marginalized lending due to the CRA or the GSEs or subprime lenders were the cause, and yet it was households least in need of generous credit terms that were the source of demand?

The proportion of mortgage debt held by households that was for non-primary residences did rise from about 8% to 12% from 2001 to 2007. But, the total mortgages outstanding in the GSE and Ginnie Mae pools grew by less than 1% in 2004 and only by 3% in 2005 before rising by about 8% in 2006. Part of the reason investor buying took over and private pool securitizations took over was because financing for owner-occupiers through the GSE's and Ginnie Mae was drying up.

One of the worst side-effects of centralized economic policy management is the problem of attribution error and the human bias of attributing outcomes to our innate sinfulness. The gods have always been angry with us. There is this terrible, terrible idea that seems to be widely believed among practitioners, academics, and policy makers, that investors become complacent if we have long periods of stability, and that a good dose of pain is, in the end, useful. So, we all congratulate ourselves for economic malpractice.

There is literature that purports to document many past episodes where this lack of risk aversion leads to a bubble and bust. But, as far as I can tell, the consensus among the academics that work in that area is that the recent episode was a grand example of that problem. Is there anyone that believes irrational bubbles are an important recurring phenomenon, but doesn't think the recent episode is a good example? It seems hard to believe that the entire history of empirical evidence could rest on an error, but the recent crisis certainly suggests the possibility.

In the linked post, Kling points to research that shows a sort of contagion effect of speculation, that when people are surrounded by others who are speculating on an asset, they are more likely to speculate on it too. I don't have a problem with that research. I don't even doubt it. But, there is this big disconnect I see in all of the discussions about the housing market between plausible distortions in human behavior and how those distortions might explain a tripling of home prices in California over a decade. That's the problem with these behavioral explanations. Once you plug irrationality into your model, scale goes out the window. And, when scale ceases to impose discipline on our explanations, then we are free to blame the bad harvest on whatever sinful behavior was bothering us the most beforehand.

Ask yourself a question. Is there any level of home prices that would have given you pause, where you would have said, "Hm. At this point, irrationality or bubble behavior probably can't explain this anymore."? If the average home price had risen to $500,000, or $1 million, or $2 million, would you have decided that the scale had outgrown the ability of behavioral explanations to explain it? It appears to me that what happened was that the higher prices went, the more convinced everyone was in the bubble story. Now there's a model, huh?

In the version of the story I am working on, I am trying to explain the pricing behavior with supply, and there is a definite point where if prices rose above a certain level, I would conclude that supply could not explain that scale of price change.

There have been hundreds, probably thousands, of books and academic articles written on the so-called bubble. If any readers know of a single one that attempts to do this for the bubble narrative, please let me know. I don't know of any. Would it even be possible? Can irrationality have confidence bands?

The next graph is a graph of the level of mortgage debt held by households. I would love to have a housing market that wasn't built on leveraged debt. There are ways to do that. Maybe someday we can. Today, in the world we live in, housing stock expansion requires mortgage debt. As long as we are all allergic to bank expansion and as long as we insist on presuming that banks will be to blame for future housing shocks, we will be harming the most vulnerable households - renters. Because housing costs, which are borne the most by renters, will continue to rise until we allow the housing stock to expand, and the housing stock is only going to expand when banks are unfettered.

There is a common belief that the so-called housing bubble was a predation of Wall Street on the poor. This is wrong. There is predation on the poor by planning commissions and housing obstructionists. During the so-called bubble, Wall Street was mostly funding mortgages to the top 40% of households, by income. The bottom 40% are divided between older homeowners who have little or no mortgage debt and renters. The bottom 40% were largely untouched by the first-order effects of the bubble and bust. For the older, unleveraged homeowners, some experienced a brief gain in equity that was subsequently reversed, with little effect on their year-to-year finances. For the renters, the housing bubble meant that they may have briefly had a reprieve from relentless rent increases. This may have required a move away from the coastal cities. But, it was available. The bust has turned the screws even tighter.

I have presented a body of evidence that suggests the bust should not have happened, that what we call the bubble or the boom was simply the beginning of the process of overcoming the predation imposed by anti-development policies. But, even if we accept that there was a bubble, at worst the bubble was helping the poorest Americans at the expense of upper middle class households. Clearly, the net benefits of the bubble flowed to low income households, while it lasted, and the eventual dislocations of the bust hit the middle class and upper middle class the hardest.

The bottom 40% are an insignificant portion of the mortgage market. You want to help poor households? Then let the banks make mortgages to the top 40% - which is largely what they were doing to begin with. In 2007, 77% of mortgage debt outstanding was held by the top 40% of households, by income, and 92% was held by the top 60%. From 1995 to 2007, those predatory banks had managed to increase the proportion of mortgages issued to the bottom 60% of households from 22% to 23% - a whopping 1%!

Thursday, March 10, 2016

A few days ago, I was wondering why Yelp would still have operations in San Francisco that were staffed by low skilled workers. I suspect rent control has something to do with it. In the city of San Francisco 3/4 of rental units are under rent control!

Rent control is simply another form of Closed Access policy. It is actually a much simpler version than the restrictions on new building. The economic rents that flow to real estate owners from building restrictions have to do with a complicated set of expectations. By limiting new housing, current owners control a larger share of the future expected housing stock of the city. The future value of the total housing stock of the city will rise whether new housing is built or not. Housing demand is relatively inelastic. For nearly half a century, aggregate US spending on housing has remained at about 18% of personal consumption expenditures, even as the relative level of real housing has dwindled.

But, in localities like San Francisco, demand is even less elastic. Before the year 2000, rent affordability in San Francisco ranged between 25% and 30% of median income. In the 15 years since, largely as a result of not building, rent in San Francisco now takes more than 45% of the median income, according to Zillow. By reducing the relative housing stock, San Franciscans spend more on housing. So, the idea that the total value of San Francisco real estate may be relatively unresponsive to changes in the real housing stock is the conservative estimate. If San Francisco built enough housing simply to revert to the supply context of the mid 1990s, the total value of all real estate, including the newly built real estate, would be less than the total value of San Francisco today, without that additional real estate. This is a strange mathematical outcome, but it is strongly suggested by the data. (Here is a link to Zillow San Francisco apartments page.)

The economic rents from keeping that new housing stock off the market are earned month by month, but the expected value of those rents raises the current market value of the real estate immediately. So, current market values are a direct result of limited access, but how that value is attained is a bit of a conceptual journey.

On the other hand, a renter in a rent controlled apartment is simply receiving a transfer each month from the landlord as a discount on the market value of the unit. Rent control is simply a way to capture Closed Access economic rents for the tenant instead of capturing them for the landlord. Tenants tend to be more popular than landlords, so these economic rents are usually proudly defended. But, if Closed Access policies are the problem, then we should be just as set against this sort of collection of rents as we are when the owner collects them.

And the incivilities created by Closed Access policies are quite clear in the countless stories of San Francisco/Silicon Valley tenants in search of apartments with affordable rents. The lack of available rent controlled units is usually bemoaned by the essayist, as if they expect price ceilings to lead to a surplus. The transfer is usually treated as a transfer from the landlord to the tenant, and a certain philosophical point of view tends to cheer that sort of transfer. But, it is just as much of a transfer from the potential tenant who would have gladly paid $50, or $100, or $2,000 more for the same unit. The tenant in a rent controlled apartment is getting a transfer from the essayist that was working for Yelp for $1,500/month while paying $1,245/month on rent for an apartment 30 miles away.

And, I think that might be a clue about why there hasn't been more outsourcing. For workers with below market rent, costs aren't as high as market measures would suggest. So, limits to new development have led to a stagnating housing stock, which feeds a complicated mix of economic rents to Silicon Valley firms, highly skilled workers, and landlords. But, rent control effectively pulls some large percentage of the housing stock out of reach of new high skilled workers. Rent control imports Phoenix costs into the San Francisco housing market. Yelp could keep that low-value job in San Francisco because rent control brought Phoenix cost levels to some of their workers.

Apparently, Talia Jane wasn't one of them. Or, maybe, depending on the set of rules, she just had to take on the high costs to get in, and below market rents would only build as her tenure lengthened. In many cases, it seems as if these policies are a sort of benefit to seniority, as Closed Access policies usually are - whether it is limiting access to a labor market, or a VC community, or a trade union, or housing.

Of course, Ms. Jane blames Yelp for her financial woes, but the reason her finances are so far from manageable is more likely because of the disconnection from reality that Closed Access creates. Surely we can't expect Yelp to survey their staff about everyone's rent expense and then pay thousands more each month to some workers just because they lost the rent lottery. Sadly, there seem to be many people who don't understand what an absurd proposition that would be, and how if that was the solution it would defeat the purpose of Closed Access policies to begin with. What would be the point of saving $2,000 in rent if your employer would have been expected to give you a $2,000 subsidy to pay it?

So, effectively, rent control cuts the size of San Francisco in half. Half of it is pretend-Phoenix and half is costly, real San Francisco. That just makes the problem of finding room for the in-migrants twice as big, the effect on market rates twice as strong, and the speed with which this all comes to a head twice as fast. Rent control slows down the migration pattern and the income-based geographical segregation that Closed Access policies create. It is a way to treat the symptoms while making the disease worse.

Wednesday, March 9, 2016

Some of this will be a repeat of previous posts, but this is a sort of primer on the difference between median income growth and median income growth after rent over the past 30 years or so.

This graph compares median incomes before and after rent in Boston, Dallas, and the US. We can roughly divide this into three periods.

Until the late 1990s, gross incomes were a decent proxy for income growth after rent expenses.

From the late 1990s until the end of the (mislabeled) housing bubble, constricted housing in the most productive cities became a binding constraint, so disposable income growth after rent expense did not rise as quickly as gross incomes, especially in constrained cities like Boston.*

In 2007, we killed the mortgage market, so now housing supply is constrained across the country, and income after rent is stagnant across the country.

This graph probably understates the problem somewhat, because there has been net migration of high income households into the constrained cities and low income households out of the constrained cities, so some of the relative positive trend in income in Boston is due to compositional effects. I have more work to do on that topic to quantify it, but the pattern looks like it could be significant.

Some of the financial pressure might be ameliorated by rent control policies. But, having a landlord who resents your presence and is unmotivated to make your tenure satisfying is hardly a recipe against class resentment.

* Total housing units per adult has been falling, generally, since 1990. Comparing this graph to the graph above, the rise and fall in total housing units per adult matches pretty closely with the relative cost of rents. More housing units means higher incomes after rent, and vice versa. How can there have been a decline in relative housing units during a period regarded as a bubble? This is because everyone was watching the sharp rise in new single family home sales. But, that was mostly rising as a replacement for owner-built homes, manufactured homes, and multi-unit housing units, which were all at much lower levels than they had been in the past. We thought we were watching the measure of overbuilding, but we were really watching the replacement of single family homes in Dallas for the multi-unit homes that we can't build anymore in Boston. First I doubted that there was a housing bubble. Now, I don't even think there was a boom.

Tuesday, March 8, 2016

There was a recent dustup about a Yelp employee who posted an online essay complaining about how impossible it was to live in San Francisco on her very low wages. Yelp fired her and moved some of its operations to Arizona. I have been thinking about this issue of high costs in Closed Access cities, and this essay ties into the questions I have been wondering about.

I think Closed Access housing policies create economic rents that are shared by firms and workers. Since the source of those rents is access to real estate, profits generally flow to real estate owners through real estate rents. For low wage workers, since a large portion of their income goes to rent and they aren't able to make significant discretionary cuts to their housing budget, most or all of the rents that flow through them go to their landlords.

For higher wage workers, they can capture some of those rents by cutting back on housing expenditures. And, since shelter is usually a fairly small expense for firms, they can capture much of the rents that flow through the firm.

Given this pattern, why isn't there more pressure to outsource non-skilled work to other locations? There has been a strong pattern of high income households moving into the Closed Access cities and low income households moving out. Why had this process not reached the low skilled Yelp position in the essay?

In fact, I think one of the peculiar factors that triggered the housing bust was that California has been systematically segregating by income. The coastal core cities have been taking in high income households. This is why we see activists complaining about gentrification or demanding building moratoriums. This massive pattern of migration by income is the forest, and occasionally the newspapers find someone chaining themselves to a tree.

Migration Patterns Susceptible to Crises
Low income households, in an attempt to remain tethered to the lucrative labor market that Closed Access enables, move to the suburbs and exurbs. This reverses the normal pattern of housing stock expansion. As a society becomes wealthier, normally high income households improve the quality of the housing stock by building new, higher value homes. They leave the existing housing stock to be claimed by lower income households. So, in many cities, lower middle class housing is usually housing that was formerly upper middle class housing. The 2,000 sq. ft. ranch style house that the doctor or lawyer built in 1970 with the latest styles of laminate countertops and vinyl floors becomes the aging 2,000 sq. ft. starter home for the construction worker who just got promoted to assistant foreman in 2005.

But, Closed Access means that location trumps everything, so now, instead of building new neighborhoods, high income households are going in to the existing cities and buying up the existing housing units in good locations. This leaves the new neighborhoods to be built for lower income households. In California, this describes whole cities in the Inland Empire. So, in 2005, we had entire cities that were peopled by households with middle incomes, low net worths, and highly leveraged real estate. These are the households most susceptible to an economic disruption. But, because of Closed Access housing policies, now we had whole cities that met this description.

This is why we had the peculiar behavior of home prices during the boom, where prices of existing homes rose faster than prices of new homes. To the conventional narrative, this looks like it could be explained by the influx of low income homebuyers, enabled by predatory lenders. IW readers know that there was not an influx of low income homebuyers. This is caused by the strange upturning of the norm in housing markets. High income buyers were buying existing homes in prime locations, and lower income buyers were buying new homes in less valuable locations. There was not a shift in the marginal buyer. There was just a shift within the population of buyers about who were buying new and who were buying existing homes.

Normally, highly leveraged homes would be scattered among the existing housing stock as moderate income households moved into aging neighborhoods. But, now, all these households were in one place, and when the disruption hit in 2006 and 2007, whole cities were devastated. And, when it had become nearly impossible for moderate income households to obtain mortgages, the wave of defaults and devaluations moved first through these cities.

The New Economy and Profit Margins

Back to the main point, here. It is interesting that Yelp would have positions worth $14/hour, and that they would choose to locate those jobs in the single worst place to try to live on $14/hour. It seems clear that a position worth $14 is not a position that is capturing much value by being located in Silicon Valley. Of course, there are many tertiary positions that are tethered to higher valued positions. For instance, the janitorial staff for the executive suite must be staffed locally, and therefore funded based on the local cost of living.

But, I would expect there to be extreme pressure to move productive positions to other locations when the cost difference is so high and when labor is such a significant part of the firm's cost structure.

I think there is a complex web of causally dense factors here that form the messy foundation of our current economic challenges. One of the defining characteristics of new economy firms in sectors like tech. and finance is that there are substantial reputational and network effects that lead to a sort of winner-take-all life-cycle for firms and competitors. In tech., especially, lifecycles can be short. This leads to two factors that increase profit margins.

1) Any firm can quickly and unexpectedly be knocked from their competitive perch. This means that to justify investment in disruptive hardware or software, firms need to be able to earn back invested capital quickly.

2) Many potential competitors will not survive the early fight to be the leader in the category, so there is tremendous survivorship bias in the financials of existing firms.

So, we begin with highly risky investments that demand a higher return on investment, those investments are highly dependent on successful early-phase investment and implementation, which means that most of the costs of the eventual leaders will be sunk costs with very high gross profits, and by the time firms are recording profits, most of the sunk costs of the sector as a whole will have been written off the books of failed competitors. So, we have a set of firms where the firm-specific profit margins are very high, but the sector-wide profit margins over the full life cycle of the sector are bid down to normal levels by competitive pressures, or are slightly higher than normal because of the competitive risks.

This means that there are a lot of firms like Yelp, who, when they pay low-skilled workers $14/hour, are vulnerable to rhetoric like the rhetoric in the linked article:

After posting a heartbreaking open letter to Yelp's CEO Jeremy Stoppelman about how impossible it was to live on her paltry wages, a Yelp employee named Talia Jane was fired.
Yelp made $32.7 million last quarter. Jeremy Stoppelman is worth hundreds of millions of dollars.
The post, on Medium, narrated the difficulties and indignities of daily life in one of America's most expensive cities for the people not blessed with stock options who are powering the tech explosion. Jane worked in customer service at Yelp and Eat24, a food delivery company that Yelp purchased in 2015 for $134 million:

"I got paid yesterday ($733.24, bi-weekly) but I have to save as much of that as possible to pay my rent ($1245) for my apartment that’s 30 miles away from work because it was the cheapest place I could find that had access to the train, which costs me $5.65 one way to get to work. That’s $11.30 a day, by the way. I make $8.15 an hour after taxes. I also have to pay my gas and electric bill. Last month it was $120."

San Francisco's minimum wage is $12.25 an hour, pre-tax, so it appears that Jane is making just slightly more than that.
In a statement, Yelp said it won't comment on why she was fired (but insists it had nothing to do with the letter), but does agree that it's expensive to live in San Francisco—though doesn't acknowledge that it may be partly responsible for that state of affairs.

Later, Yelp's response on this problem is derided as "free-market dogma".

Now, if Yelp was running a local landscaping business, or a pizza delivery shop, they wouldn't have to worry about these accusations, because there simply wouldn't be any cash to spend. But, here, since Yelp is the steward of a whole lot of value at emanates from their victories in those early phases of development, they look stingy.

But, why wasn't this job already located in Arizona? I think this is part of a whole series of patterns set up by the Closed Access housing policies that now define our major cities. Isn't it interesting that these frontier industries seem drawn to cities that can't house them? I think this is a very complicated issue, and causality is messy. But, could this be some sort of emergent outcome that arises from the extreme competitive pressures these companies face?

Let's say you've "won" your category. Now, you have an outsized valuation and outsized profit margins. If you were a car company 50 years ago, your worry, on a year to year basis was whether you might gain or lose 2% market share. But, if you are Facebook, your worry, on a year to year basis, is whether you become Myspace or Friendster. So, what if locating in Silicon Valley greatly increases your costs (which are very low on a cash basis) but decreases your chance of becoming Friendster by 10% every year. That's a no brainer. You pick up your operations and you move them to Silicon Valley.

This brings us to Yelp and Ms. Jane. Is it worth having her position in Silicon Valley? Well, compared to Yelp's $32.7 million in quarterly profits, Ms. Jane's $14/hour is paltry. But, what if the ease of communication supported by having the operation she works in located in Silicon Valley decreases the existential risk for Yelp by 0.001%. Probably worth the cost. Now that Yelp is the category winner, those profits are well-used by building an expensive moat around the organization.

Partly, I think there are inefficiencies here, which in finance have been well-covered, regarding firms with large cash holdings or high profit margins. When the risks to a firm of inefficient operations or financial management aren't imminent or palpable, it is difficult for the discipline of the marketplace to work sharply. So, this state of affairs is a combination, I think, of inefficiencies and of complex efficiencies that tend to be misunderstood.

But, I'm afraid, in either case, Ms. Jane's position probably should have been located in Arizona to begin with, and the commonly prescribed solution to her problem, to expand policies like rent controls in a city already toppling under the weight of such incongruities is to simply double down on the Closed Access policy framework at the heart of the problem.

But, maybe firms like Yelp would never have been funded in the first place if that moat didn't exist. Have Closed Access cities become valuable because frontier investments have taken on a winner-take-all character? Or have frontier investments taken on a winner-take-all character because Closed Access cities were available as a competitive barrier? Could the modern tech. revolution have happened without this competitive moat?

Very few of us would give up the incredible technological advances of the past 20 years. But, these advances are helplessly intertwined with the development of these Closed Access policies. And Closed Access policies invariably lead to incivility, inequality, and economic stress. There are few things I feel more strongly about than that we should fight the tendency to impose Closed Access policies. But, what if there is some tipping point with revolutionary innovations? What if capital inflows to revolutionary innovations become uneconomical without a little bit of competitive protection? If giving up Closed Access policies and their related social disorder meant that I would have to give up Yelp and Facebook and BlogSpot, is that a trade I would be willing to make?

It seems as if I am being extreme here. Surely Closed Access policies aren't that important. Surely most of the recent developments of frontier consumer technology are natural outgrowths of the current state of the art.

I have sort of been pushed to this idea through the back door. Here is a chart from a speech (pdf) from Ben Bernanke comparing home prices during the boom to changes in each country's current account. Now, Bernanke sees this as a defense of his monetary policies. He sees a savings glut in the developing world as the causal factor bringing capital into the developed world, pushing down real interest rates, and thus pushing up property values. But, that causation leaves many mysteries, including the first obvious question, "Why did that capital flow to Australia but not Germany?" This is a similar question to the question we should ask about the US housing bubble. "Why did predatory lending lead to home prices doubling in coastal California but not in Texas (where many of the new homes were being built, after all)?"

The answer to both of these questions is that supply is local. Closed Access policies are local. The causal factor here is Closed Access policies. Firms located in these highly innovative economic centers that had competitive moats around them because of real estate limitations, could capture economic rents. I am developing the idea that the capture of these rents is pulling down real incomes for the rest of the US. When we click an ad on google, a micro-penny gets transferred, eventually, to the bank account of a landlord in San Francisco. But, these firms are also capturing rents from the rest of the world. Most of those excess profits are captured through foreign subsidiaries. Bits don't have to be routed through the shipping terminals in LA, so they don't get recorded as international trade flows. But, they do add to the value of those international subsidiaries. This is why we have the mysterious situation where US assets held abroad consistently earn higher profits than foreign holdings of US assets, even though, year after year, foreigners invest billions more dollars in the US than we invest abroad. This is because our corporations earn very high profits on their foreign activities which they continue to reinvest. Foreign savers must continually send new capital to the US just to keep from falling behind. And, to get the dollars to do that, they must sell us something. The US trade deficit, at least in part, is a measure of the economic rents we earn from the rest of the world from our Closed Access housing policies. The trade deficit isn't unsustainable. We have already paid for those goods with the foreign profits of our corporations.

So, the causation starts at Closed Access policies. This leads to both inflated home values and to excess foreign profits which lead to capital inflows as foreign nations that don't have access to these economic rents seek capital income to keep pace.

One of the tests of causation here would be to measure rents. If the cause of these flows was a savings glut in the developing world, then that inflow of capital would trigger more homebuilding, so we would see falling rents and rising prices in countries with growing current accounts (inflows of capital). If the cause was Closed Access policies, then we would see rising rents in those countries. The rising rents would be the cause of both the rising home prices and the capital inflows, which are both simply the transfer of economic rents to the owners of Closed Access assets. Much detailed work needs to be done here, but as I have shown in the US, the positive
relationship of rents to home prices is very strong. And, that seems to be the case in the international context, too.

Friday, March 4, 2016

"The biggest source of inflation is shelter aka Real Estate. Real Estate inflation has been surging for years thanks to the Fed's specific policies aimed at boosted real estate property prices. It's likely that recent tightening will slow this inflation.
The Fed created this part of the problem and is now, belatedly, addressing it."

There are so many errors packed into such a short and seemingly irrefutable statement.

Shelter inflation is not "real estate" inflation. Shelter inflation is rent inflation. Rising rents certainly can make homes more valuable and increase the prices of homes. But, if we are talking about Fed policy and interest rates, then no. If home prices rise because of interest rate policies, it has no effect on rent inflation.

In fact, if home prices were rising because of low interest rates, then rent inflation would be falling, because it would induce more home buying and more supply. In fact, the persistence of rent inflation while housing starts struggle along at extremely low levels would be the first obvious fact to look for as a confirmation of failing supply. This would be a sign of, if anything, Fed policy that is too tight and rates that are too high.

Fed tightening will only cause rent inflation to decline if it tightens so strenuously that it triggers another crisis that causes major permanent re-adjustments in household spending. Households are already spending more of their incomes on rent than they ever have before, for less real shelter, so it remains to be seen whether households would be willing to adjust any more, in the aggregate. It could be that more tightening will cause more adjustments in other discretionary spending as households hunker down in the minimum real level of shelter consumption they are willing to accept.

Of course, owner-occupiers won't feel much of this directly. It will be mostly felt by renters.

And, why are housing starts so low, if home prices are so inflated? This is a pretty basic question that would need to be answered before the (seeming) entire country decides that homes are overpriced because of Fed policy. Somebody needs to send a memo to the homebuilders.

But, to even address that error, we have to address the error that near zero interest rates are a policy choice, as if we would be at 4% if the Fed had wanted to peg us there. Not to mention that the most significant policy decision of the past 20 years has been the series of Fed decisions that pulled the rug out from under the housing market from which it still hasn't recovered.

So, rent inflation has the opposite reaction to Fed policies that ZH thinks, which are actually the opposite policies that ZH thinks they are, which have pushed real estate prices in the opposite direction from what ZH thinks they did. Tightening will slow inflation in every category except the one ZH thinks it will. The Fed did create this problem (ZH got that one right) but the problem is the opposite of what ZH thinks it is, and thus the tightening is coming too soon, if anything, not belatedly.

Wednesday, March 2, 2016

My blogging might be a little spotty for a while, because I am working on the book.

Here are some charts of housing starts, which include manufactured housing, which I think brings up an interesting point about perceptions during the housing boom.

The first graph is of homes built for sale and homes built by owner. Note that there was a sharp uptick in homes built for sale, but homes built by owner had actually fallen.

The next graph has the total level of 1 unit housing starts, plus multi-unit starts, plus manufactured home shipments, and the total starts and shipments of all types. They each include a dotted line of the average level over the period of the data in the chart. I haven't taken the time to do it here, but if we just use the average for 1963 to 2005, before the bust, total starts and shipments was barely even above the average. We can see here that, even without adjusting for population, housing starts + shipments at the peak in 2005 were normal for an expansionary period.

That is why the housing stock, relative to the population was flat. (It was actually declining relative to the population over 16 years of age.) There wasn't even a housing boom. We all just decided to freak out about the one type of homebuilding that was growing - single family units for sale - and ignoreevery single other category of housing supply, which included homes built by owner, multi-unit homes, and manufactured homes. All of those categories had been in decline. Of course, it was the decline that created the illusion of a boom, because it was precisely those cities where we can't build, yet where income opportunities are available, where home prices were skyrocketing, because households were bidding up the stagnant pool of homes in those cities in an attempt at economic opportunity in a country that has become inflexible.

In an economy that has arbitrary limitations on supply, especially political limitations, the least powerful citizens get pushed aside. They have been getting pushed aside - pushed from New York and Boston and California to Atlanta and Dallas and Phoenix and Riverside. Now they can't even be pushed, because we decided only the wealthiest can get mortgages. We need to protect the others. So now they are nice and safe between a rock and a hard place. It is true. If we prevent them from ever owning anything, we will be preventing them from ever having a default or a foreclosure. That's how much we care.

You know all these discussions serious people have been having for a decade about the housing bubble and the oversupply that inevitably had to pop? We didn't even have it. Didn't exist. Never happened. We might as well be arguing about what caused the sudden rise of civility in American politics.

Here is a map of shipments by state. Guess which states tend to accept a lot of shipments of manufactured homes, which are an inexpensive way for low income households to become homeowners.